Friday, June 26, 2009

ISPs giving content providers a free ride? Quite the opposite!

Nothing annoys me more than companies that complain when they can't continue doing business the same old way in a changing world.

Working in IT can be both exciting and treacherous. This is probably the only industry where the entire landscape changes completely every five years, garage-based start-ups can become household names in less than that, and international behemoths can be humbled, bankrupted or swallowed whole in the blink of an eye. If you work in this field, you have to be prepared to switch your entire operating model around at the drop of a hat when the same thing that was churning out the billions yesterday has become laughably obsolete by lunchtime.

Internet Service Providers (ISPs), the companies that provide the connectivity that makes the Internet possible, have been the quiet worker bees of this massive hive for at least two decades now. Their industry has gone through a few transitions, most notably the move from dial-up to broadband, but the basic economics remain the same. At the retail level, punters pay their ISP a fixed fee per month (in the UK, this usually ranges from £5 to £20) and get a broadband connection to their home - what, in my day, we used to call a phat pipe. Through this connection you can access anything and everyone who is connected to the Internet anywhere else in the world. Video chatting to your mate in Tokyo, browsing through the catalogue of the U.S. Library of Congress (though sadly not the contents, and you can blame our stone age copyright laws for that), downloading Wacko Jacko's (R.I.P.) entire discography for your own personal mourning marathon - all this and so much more is yours for the same monthly price.

This idea of hooking up at one end of the Internet and getting access to everything - and the flip side of the idea, that you can offer a service and immediately have it available to everyone - is at the core of the Internet, and what makes it work so well. The content providers put their content up (and make their money through advertising, subscription fees, or by selling you Real Stuff through their online shop front) and the access providers - the ISPs - connect people to this content, and never the twain shall meet. This separation of the access market and the content market is the key to the success of the Internet, because it avoids the monopolistic tying of content to access that plagues other media such as television. You'll never have to switch ISPs because yours won't let you access YouTube; you'll never be forced to buy from Amazon because your ISP partners with them. This separation is what allows market capitalism to work its magic on both ends of the equation and provide the vibrant economy of the Internet.

But all is not well in the magic kingdom. John Petter, managing director of BT Retail - one of the largest ISPs in the UK - is annoyed that his customers are using their broadband connections to watch television on the BBC iPlayer because it's causing so much traffic that it's hurting his profit margins. For those not in the UK, iPlayer offers all the BBC's television programming from recent weeks on demand, and is quickly replacing BBC TV for many people as they enjoy watching shows whenever they have time as opposed to whenever the shows are on. Mr Petter told the Financial Times, "We can’t give the content providers a completely free ride and continue to give customers the [service] they want at the price they expect."

BT retail is not the only ISP to whine about content providers getting a "free ride," and the phenomenon is hardly confined to the UK. Google's YouTube service has also been the target of similar complaints by US ISPs. On the face of it, Mr. Petter and his colleagues have a point, but a basic knowledge of the way the ISP business works - which I would expect BT Retail's MD to have - is all that is needed to show how patently wrong they are.

First of all, none of these services get a free ride. The main reason that content and access providers are separate is that from a practical point of view there is absolutely no difference between a content provider and an end user on the Internet. Think of it this way: when you and your hypothetical Tokyo-dwelling friend start a video chat, you're just two end strands of the vast web that is the Internet. Assuming a relatively simple case, you pay your ISP in the UK, and he pays his ISP in Japan. Both of your ISPs have connections with a large international backbone ISP whose network spans the divide between Old Albyon and the islands of the Rising Sun. These connections will probably be based on what is called a transit agreement, where each of the small ISPs pay the big ISP so that they can send it traffic which it will route through its network and deliver at the other end. The small ISPs take your money, give some of it to the big ISP for transit, everyone adds on a bit to make a profit, and everybody's happy. In reality, there may be several ISPs between yours and his, but the principle is the same.

What's important to realise is that having a video chat with your friend in Tokyo is no different to watching a video on YouTube. YouTube (and iPlayer) pays for internet access just like you and your friend do; the fact that it serves up massive amounts of video may affect the size of its ISP bill, but it doesn't affect the way things work. On the Internet, sending and receiving, or download and upload, cost the same. The ISP that has one big customer like YouTube that uploads terrabytes of data and the ISP that has millions of small customers like you or me who download just megabytes each, each pay the same transit fees for the traffic to be routed through the Internet via the other ISPs they connect to.

One of the things that ISPs do to add value to their service is abstract all of this away and offer consumers a flat monthly rate. Their cost structures can be complex with each byte you transfer being anything from (incrementally) free to hideously expensive for them depending on where it's coming from or going to. ISPs average out these costs and present you with a fixed cost at the end of the month, reasonably adding a margin on top for their own profit.

But ISPs can also do a lot to make these bytes cheaper. In our example above, if the two ISPs in the UK and Japan found that a lot of their customers were transferring data between themselves, they could create a connection between themselves and sign a peering agreement. Peering, unlike transit, is free, but only transfers data between the two peers - it won't forward it on to the rest of the Internet, and they'll have to continue using transit agreements for that. If the cost of maintaining a direct connection between the two peers becomes less than what the big ISP is charging them for transit, they can cut out the middle-man and increase their profit margins by peering, probably giving their users faster service while they're at it.

This wonderful, elegant and simple system of peering and transit - one free, one paid for - has allowed the Internet to grow as fast as it does by giving anyone an incentive to lay down a connection wherever there is demand for it. Any shrewd businessman can start out small in the ISP market by getting some customers and buying transit off one of the big boys, and grow his business by getting more customers on one end, and striking peering deals and finding cheaper transit on the other. Low barriers to entry, few externalities, no capacity for preferential exclusivity agreements - market capitalism at its absolute finest.

So we can dismiss the idea that iPlayer and YouTube are getting a free ride. Not only do they pay their ISP bills just like you and I, but their mere existence is what drives the demand for people to get hooked up in the first place. For every byte of video a BT Retail customer watches on iPlayer, iPlayer pays its ISP, the customer pays BT Retail, and through the magic of transit and peering agreements the ISPs that link the two together each get their proper cut to cover the cost of moving the data around.

So why all the complaining? If iPlayer causes increased traffic, but that traffic is paid for on both ends, what's everyone complaining about? If you've been reading carefully, you've probably already spotted it: BT Retail charges a fixed monthly fee to their customers. Up until very recently, this fee was based on your connection speed - an 8 megabit connection goes for about £10/month, a 16 megabit connection goes for £15, etc. BT Retail, like all ISPs, arrived at this number by figuring the cost of its infrastructure and adding on the transit fees it has to pay to the ISPs it connects to and dividing it by the number of users, adding in a profit margin - with competitive forces keeping that margin narrow and driving prices down.

An 8 megabit (per second) broadband line can theoretically transfer 1 megabyte (1 byte = 8 bits) per second, or 60 megabytes per minute, 3.6 gigabytes per hour, 86.4 gigabytes per day, so about 2.6 terrabytes of data a month. For traditional "unmetered" broadband, your 10 quid a month theoretically allowed you to download all of this. In practise, most users will download only a tiny fraction, with their broadband lines sitting idle most of the time - not just because they'd have nowhere to put all that data, but also because there just isn't that much stuff out there they want. Before MP3s, this fraction added up to maybe a few dozen megabytes per month. Before YouTube and iPlayer, perhaps up to a gigabyte. However, now that we use the Internet for video, and you can rent HD movies clocking in at 5-10 gigabytes each from iTunes (let alone download them for free off BitTorrent, which actually costs your ISP twice as much since you're uploading them at the same time) it's completely reasonable for an average home user to download 20, 30 or 100 gigabytes in a month.

So the problem has nothing to do with content providers getting a free ride - it's more to do with ISPs charging you by your connection's theoretical maximum speed (which most users are unlikely to ever see anyway) when their costs depend on the actual amount of data transferred, all the while assuming you'd only use about 0.01% of the actual capacity. When you suddenly increase your usage a hundredfold to 1% of your line's capacity because you've gone from sending e-mails and reading the news to watching YouTube and iPlayer, their transit fees go up but your access fee stays the same.

That's nobody's fault but your own, Mr. Petter, and whining about the content providers will achieve nothing. For years you've been trying to upsell people to 2, 4, 8, 16, 24 megabit connections that they had no use for by assuming they'd use about a hundredth of a percent of the bandwidth they were buying, and when the supply side caught up and gave them something to do with their bandwidth, you complain.

So what should ISPs do? Well, for a start, what they're already doing; if you're paying attention you'll notice that most ISPs have de-emphasized the maximum bandwidth of their connections and are already pricing them based on maximum traffic per month (so from 8 megabits per second, the headline figure is now 10 gigabytes per month). Also, what they've always been doing; if 7% of BT Retail's traffic is coming from iPlayer and it's killing them in transit fees, perhaps they should strike up a peering agreement with the Beeb and fix those costs, probably improving the experience for their users in the process as they get a direct, high-speed line to the iPlayer servers. Once that is done, you can go even further by striking a deal with iPlayer to mirror their content on local servers so it costs even less to stream it to your users.

What annoys me most about these complaints is that looking at things right now, it's the content providers that are getting the short end of the stick. Sure, BT Retail may have to adapt a little to keep its profit margins, but as I've shown above this can be done pretty easily. On the other hand, both YouTube and iPlayer are operating at a loss - one as a loss leader for Google, the other funded by the TV license fees that all UK residents who own a TV must pay - while BT Retail sells broadband to people who want it so they can access YouTube and iPlayer - and the latter don't see a penny.

If anything, it's the content providers that need a way to get a slice of the ISP's revenues, not the other way around. I've already talked about this in previous posts, but it's important to do this in a way that doesn't mess with the Internet's basic separation of content and access, or we will lose precisely that quality that makes the Internet such an innovative place. How can ISPs achieve this?

The answer is to charge content providers not for the use of their network infrastructure (which they already pay for, indirectly) but a much more important asset: Their billing system. ISPs already send you a bill for your Internet access every month. What the Internet needs is a standard - as open and egalitarian as the peering and transit system - that will allow content providers to tag on subscriptions to their content - think Wall Street Journal or Financial Times, think Spotify, think academic journals - to your ISPs bill so you don't have to enter your credit card details and get a separate bill every time you sign up to a premium content service. Set up a global clearing system (a job for the folks at Visa or SWIFT perhaps?) and everybody's happy - content providers can easily sign up subscribers, ISPs get a cut of the subscriptions for handling the billing, and users can pay for content (and even goods) on the Internet in a simple and secure way.

So, please, all you ISP managers, stop whining about free rides and get together to figure out how to make your most important asset - your billing system - available to those who need it the most.

No comments:

Post a Comment